Notes on This Week’s Column: Getting China to Spend

My column this week deals with one of the bigger long-term challenges the global economy faces, which is the need for China to save less and spend more. Given the importance of savings and investment to economic growth—and given the current obsession in the U.S. with our soaring deficits—the idea that a country could actually spend too little may sound peculiar. But that’s precisely the situation that China finds itself in. Because consumption makes up such a small share of the country’s G.D.P., China’s economic growth depends largely on the willingness (and ability) of the U.S. and other developed countries to buy its goods, and on its own investment in factories and infrastructure at home. And the fact that China saves so much means, as Martin Wolf recently pointed out, that it’s putting huge amounts of money into low-yielding investments (like, most obviously, U.S. government bonds) instead of spending it on things that could dramatically improve people’s everyday lives, like a more robust social safety net. To be sure, this is all part of a complicated economic calculation: in effect, China lends money to the U.S. that Americans use to buy Chinese goods, which keeps Chinese factories humming and Chinese workers employed. But if more were being done to encourage domestic demand, the factories could stay open and Chinese consumers would actually be better off, too.

The curious thing, as I point out, is that it’s very hard to find people who disagree with this argument. Here’s Barack Obama talking about the need for China to do more to spur consumption. And here’s a report on a recent speech by Hu Jintao in which he said that the Chinese government was going to “vigorously” boost consumer demand. Pundits and economic analysts, too, have emphasized the importance of the Chinese consumer. (One exception to this consensus is those who argue that increasing Chinese consumption will be disastrous for the environment.)

Much of the discussion about rebalancing has focussed, understandably enough, on the question of whether China will revalue the yuan. By holding down the value of the yuan, China makes its exports to the U.S. cheaper (and American imports more expensive), which obviously contributes to the trade imbalance between the U.S. and China, but also restrains Chinese consumer spending, since it keeps consumer prices in China higher than they otherwise would be. But while there’s little question that the yuan is significantly undervalued, it’s not the main explanation for the fact that consumption makes up such a small (and declining) fraction of Chinese G.D.P. (The shrinking importance of consumption can be seen in this pair of remarkable charts.)

One popular explanation for China’s thrift is the legacy of Confucianism. Culture obviously affects people’s attitudes toward spending and saving, and there’s no reason to think that the Chinese will ever be as profligate as Americans are (nor would that be a good thing). But as the historian Michael Pettis explains, there is no obvious or necessary connection between “Confucian values” and high savings rates, and, in fact, in the past Confucianism has been invoked to explain Asian poverty, while now it’s being used to explain Asian prosperity. Far more important, I argue, is the way China’s economy has been structured. This McKinsey Global Institute report—appropriately titled “If You’ve Got It, Spend It”—offers an excellent overview both of the current state of consumption in China and of the myriad challenges that need to be overcome in order for the country to strike a better balance between investment and consumption. The report also makes a strong case for the core argument of my piece, which is that making the Chinese economy more consumer-friendly will actually end up boosting economic growth rather than slowing it. There’s a limit to how much money, after all, China can invest wisely or efficiently. And the lower the returns on investments in new factories—or U.S. bonds—the more sense it makes to channel more resources, either directly or indirectly, toward consumers.

That should entail, as McKinsey points out, improving consumer credit and consumer choices. (While China’s big cities feature a cornucopia of retail outlets and products, much of the country doesn’t.) It also entails improving the social safety net, from unemployment benefits to pensions to education to health care. This extraordinary article by Geoff Dyer in the Financial Times details the travails Chinese workers face when they get sick, while this paper by Marcos Chamon and Eswar Prasad argues that a significant cause of the rising savings rate among urban households in China is the need to put money aside for housing, education, and the risk of illness.

Perhaps the biggest challenge China confronts in boosting consumer demand is that in order to significantly increase consumption, you also need to increase wages. As The Economist pointed out earlier this summer, much of the investment that’s gone into China has funded capital-intensive projects, rather than labor-intensive ones. And McKinsey suggests that the economy’s continued reliance on large, state-owned manufacturing enterprises, which tend to be capital-intensive and inclined to reinvest profits or retain earnings rather than raise wages or issue dividends, has kept consumption down. (One subject that has not been much discussed, interestingly, is whether the absence of a genuinely independent labor movement in China has had any impact on wages.) Here again, though, the potential for improvement seems bright: if more money is put into the consumer-services sector (like retail), you could get a virtuous cycle: as options for consumers expand, they’ll be willing to spend more (since they’ll get more bang for the buck), and since services are more labor-intensive, employment will rise, putting more money in the hands of Chinese households, etc. This doesn’t mean that China is going to (or should) stop being the factory of the world. But it does mean that, as its own policymakers seem to recognize, there are real gains to be reaped both at home and abroad by getting Chinese consumers to spend.

James Surowiecki is the author of “The Wisdom of Crowds” and writes about economics, business, and finance for the magazine.